One of the big turnaround stories of recent years has been the reversal in fortunes at aeronautical engineer Rolls-Royce (LSE: RR). Over the past five years it has transformed from a cash-burning enterprise dealing with a pandemic-era downturn in civil aviation to a profitable company with the wind in its sails. Rolls-Royce shares have soared 1,234% during that period.
A year ago, things were already looking much better on the business side of things. But after several years of bumper gains, were the shares still a bargain?
More than double in one year
With the benefit of hindsight, they clearly were.
Over the past 12 months, Rolls-Royce shares have moved up by another 110%. So an investment of £20k a year ago would now be worth around £42k.
Plus, those shares would be earning around £252 a year in dividends.
The rise in the share price over the past year has pushed the yield down for someone buying today, however. It now stands at around 0.6%.
Hindsight’s fine but what comes next?
Of course, as investors, hindsight is too late for us when it comes to a specific transaction, although hopefully over time we can learn more and make better judgements in the stock market.
What about foresight?
None of us knows for sure what will happen next. That is why the stock market is just that… a market. Different investors each have their own view on what a share is worth, because they do not know for certain how a business will perform in future.
Rolls-Royce shares have done well largely because the business has recovered solidly, is being well run with a focus on meeting its financial goals and customer demand remains buoyant in all three of its key business divisions.
Not only has civil aviation bounced back, but defence and power systems markets are seeing strong sales.
With its powerful brand, large installed base of jet engines that need ongoing servicing and proprietary engineering technology, Rolls has multiple strengths. They could help its ongoing journey to improve profitability and cash flows.
Should I invest now?
Although past performance is not necessarily an indication of what to expect in future, there is no getting away from the fact that Rolls-Royce shares have been on fire over the past few years.
I like the business model and reckon the company’s financial performance may improve, given strong customer demand and management’s focus on achieving the company’s ambitious performance goals.
However, I see risks too. With its market capitalisation of £106bn, I am not convinced that the risks are properly factored into the current valuation.
A sudden, unexpected, event could send civil aviation demand sharply downwards overnight, hurting revenues and profits badly – exactly what happened to Rolls during the pandemic.
Geopolitical concerns are also both good and bad. They have helped boost defence sales. But they bring an ongoing risk of tariffs and other trade disputes that can be costly for a multinational business with a complex supply chain, such as Rolls.
For now, I will not be investing.
